Is our pension salary exchange scheme compliant?

workplace wellbeing

What employers need to know

The vast majority of workplace pension schemes have embraced the benefits of pension salary exchange (also known as salary sacrifice), meaning employees and the employer are making valuable National Insurance (NI) savings. There are, however, certain requirements that need to be met to ensure the arrangement is deemed compliant in the eyes of HMRC.

Firstly, salary exchange is not a pension arrangement but is a payroll arrangement. It is a rearrangement of the payslip deductions that creates the benefits for employees and employer. Pension providers will accept contributions from employer and employees on the monthly schedule in any method the employer submits.

To employees, who are quite often bamboozled by pensions, we explain that salary exchange is a change in the priority of deductions. Instead of tax, NI and then pension deductions salary exchange means pension, then tax and NI. There is more to it than simply reorganising deductions but this simple explanation makes it easier for employees to comprehend.

A compliant approach is vital as the move to salary exchange is a change in the employee’s terms and conditions of employment. The employee is taking a pay cut, the exchange, equal to their pension contribution, and the employer is adding the exchanged amount to the current employer contribution, ensuring the same overall contribution level is maintained. Any change in terms and conditions require compliant documentation and communications confirming the terms of the exchange arrangement. These include:

1.  For existing employees a contact addendum should be in place explaining the exchange.

2.  New hire contracts should be amended to explain the exchange.

3.  Salary exchange rules need to be drawn up and made available to employees. The rules should set out the exchange terms, such as start date, maximum allowable exchange contributions, any rebate of the employer’s NI saving to the employee’s pension and conditions of the employee being able to change the exchanged amount.

4.  Dummy payslips showing before and after exchange examples should be run before the exchange goes live and audited to confirm the exchange is calculated properly.

5.  Pension scheme documentation should include details of the exchange arrangement. We have a specific salary exchange booklet which employers host on their intranet or keep in HR to give the employee a more in depth understanding.

6.  In most situations we advocate a non-affirmation implementation of salary exchange but this requires a specific chain of communications, including lead up communications, presentations and a salary exchange  opt-out (not to be confused with Auto-enrolment) period for employees who do not wish to be included in the exchange arrangement.

7.  The monthly pension schedules should be checked to confirm that the contributions of those included in the exchange have been amended to employer only and the correct payment amounts continue to be made.

8.  It is not a compliant requirement but higher and additional rate tax payers should have targeted communications to explain the different tax relief treatment between net pay and salary exchange deductions. It is essential that higher and additional rate tax payers check their notice of tax coding to ascertain whether they have higher rate tax relief included in their personal allowance and if so notify HMRC of the move to salary exchange to avoid double tax relief.

Salary exchange will not have any effect on other salary related benefits such as Group Life Assurance and Group Income Protection. These benefits, as well as future pay reviews, will be based upon the pre-exchange salary.

HMRC have recently removed the ability to obtain approval for pension salary exchange arrangements but this does not remove the need for compliance. A well-constructed and communicated salary exchange implementation project provides valuable savings for employers and their employees and is more likely to comply with HMRC’s requirements.


Download our guide to salary exchange

Salary exchange is designed to be a tax-efficient way of making personal contributions into a workplace pension.

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